A butterfly reorganization is a corporate restructuring that divides a corporation's property among two or more corporations on a tax-deferred basis, typically to split assets among shareholders who are going their separate ways. It relies on an exception within the dividend-conversion rule in section 55 of the Income Tax Act.
The structure is technically demanding. The property transferred to each transferee corporation generally must be distributed pro rata across prescribed asset categories — cash and near-cash, investment property, and business property — so that each recipient ends up with a proportionate share of each type. Failure to meet the pro-rata and other conditions can cause an otherwise tax-free intercorporate dividend to be recharacterized as a capital gain. Butterflies are most commonly used in corporate divisions and shareholder separations.